Bull in a China Shop?

China’s status as the world’s largest economy is no reason for hubris  |  China’s status as the world’s largest trading nation and, during 2014, as the world’s largest economy should be treated with caution by markets. It is still an emerging economy, faces manifest problems in terms of structural reform and has a difficult year ahead of it in terms of trade and economic growth. Observers would do well to treat the news about its size with the ambivalence it deserves: over-reaction, which is admittedly absent at present, could add further challenges to China as it seeks to impose major structural reforms without causing a sovereign debt crisis. It is no longer growing, either in trade or GDP terms at the rate that it was pre-crisis. This is a fact, and one that should concern markets more than the size of the Chinese economy, which does little more than beg the question, “so what?”

In October 2011, Delta Economics predicted that China would become the world’s largest goods trader by 2014. In January 2014, China officially became the world’s largest goods trader (1) in the world accounting for over 13% of world trade according to our estimations. Last week the World Bank (2) announced that China would also become the world’s biggest economy, in 2014, a fact which surprised many economists who had forecast that this would not happen until 2019; it also frustrated the Chinese government. There is some scepticism about the materiality of the numbers themselves because of the way in which they are calculated but, as Martin Wolf (3) points out, it is a reasonable, even an unsurprising conclusion and does not mean that China is the world’s most powerful economy.

The Delta Economics view is that China should indeed be regarded as an emerging economy. This means that analysts should be looking for evidence that its economic fundamentals are catching up with those of the developed world to justify investment decisions.

First, there is no better place to start than in a closer examination of the structure of its trade. China is not catching up quickly with either Germany or the United States in terms of the goods it imports and exports and, indeed its trade is becoming more concentrated in its top ten exported and imported products rather than less. In import terms, this means that it is still importing predominantly commodities and intermediate manufactured goods while in export terms, its exports are heavily concentrated in computers and intermediate machinery. As Figures 1a and 1b show, the fact that the “rest” component of the top 30 sectors has fallen so sharply, suggests that the reliance on these sectors in export and import terms has increased.


Bull in a China Shop  |  Figure 01a

 Figure 1a  |  Share of China’s top 10 export products as a percentage of its top 30 export products, 2014

Source  |  DeltaMetrics 2014

Bull in a China Shop  |  Figure 01b

 Figure 1b  |  Share of China’s top 10 import products as a percentage of its top 30 import products, 2014

Source  |  DeltaMetrics 2014

Figure 2 compares the structure of China’s trade with Brazil, India, Russia, Germany and the US in 2001 and 2014 using the Finger-Kreinin Index, which measures the similarity of the structure of exports between countries. Effectively it is a measure of how a country is catching up/competing with another in terms of its exports. The closer the value is to zero, the less similar the structure of exports is – in other words, the country comparator as few export sectors in common.


Bull in a China Shop  |  Figure 02


Figure 2  |  Finger-Kreinin Index for China’s export similarities with selected countries

Source  |  DeltaMetrics 2014

What the figure quite clearly shows is how different China’s structure of exports is to other countries, whether developed or emerging. It is more like a developed world economy that Brazil, India or Russia since electronic goods and intermediate goods dominate its exports as compared to the dominance of commodities in the other countries. Only India shows any sign of a major shift towards export similarity, but as the value is still low, at 0.13, the change does not suggest that India is competing directly with China.

Of more interest is the fact that neither Germany nor the US are similar in terms of their exports either. China has become more like the US over time, although it is still very different and Germany became mildly more similar immediately pre-crisis with slightly higher values (0.12) which is arguably because of a shift in German manufacturing out to China at that time which has since performer5 coupon code reversed. Similarly the biggest shift in the similarity of US export structure to Chinese was in the same period and has not yet reversed.

But the fact remains that neither selected emerging economies or the two other, largest, trading nations, are at all like China.

Second, while Barclays Capital, argues that China’s trade is not growing fast enough to keep investors happy, the effects of Hong Kong are dampening prospects for growth. Strip the effects of Hong Kong out, and export growth last year was 6.8%. This is very close to the Delta Economics similar estimate of Chinese export growth of 6.9% in 2013 suggesting that the Hong Kong factor is an important one to consider.

It is necessary to exercise caution when looking at the relationship between Hong Kong and China in trade terms. Because Hong Kong is a semi-autonomous region, it counts as part of China for some import and some export purposes. Thus, re-imports into China (which are the proportion of imports from, say, Hong Kong or China Macao that originate in China) grew from 4.5% of the share of top 30 importers into China to nearly 10% now.


Bull in a China Shop  |  Figure 03


Figure 3  |  Chinese exports to key port nations, USDm, June 2001 – January2016

Source  |  DeltaMetrics 2014

The figure shows Chinese exports to key port hub nations. Clearly it exports more to Hong Kong than it does to other port nations but this figure suggests two things: first, the volatility of China’s trade with Hong Kong has increased since 2009 and follows a regular pattern and second, that trade with Singapore and the Netherlands grew faster year-on-year in the first quarter of 2014 that exports to Hong Kong.

Third, the volatility in particular suggests that Chinese trade inflows and outflows themselves do not necessarily reflect the trade fundamentals, which have remained very similar since 2001. And yet, the Hang Seng index and Chinese exports are extremely highly correlated, with a value of 0.81 suggesting that this volatility may even be helping investors to predict where that market might go in the future, as illustrated in Figure 4.


Bull in a China Shop | Figure 04

Figure 4  |  Chinese exports versus Hang Seng, Last Price Monthly, June 2001 – March 2014

Source  |  DeltaMetrics 2014 and Bloomberg

It is this last point that is the most important. The correlation between markets and Chinese trade is strong, but much stronger for emerging markets than it is for developed world markets, even regional ones like the ASX 200 or the Nikkei (Figure 5) and, as shown in Figure 6, the relationship between the S&P 500 and Chinese exports is negative from the end of Q1 2013.

Bull in a China Shop | Figure 05

Figure 5  |  Correlation of Chinese exports with key regional markets and the S&P 500

Source  |  Delta Economics own analysis

Bull in a China Shop | Figure 06

Figure 6  |  Chinese exports (USDm, June 2001 – Dec 2014) vs S&P 500, Last Price Monthly, June 2001 – March 2014

Source  |  DeltaMetrics 2014 and Bloomberg

All of this illustrates the importance of China’s exports to emerging equity markets. These watch China’s economic indicators and react accordingly, perhaps because the emerging countries in the Asia-Pacific region are so dependent on China’s economic health. Interestingly there is a relatively weak correlation with the ASX 200 and one that turned negative in early 2010.

There are lessons for investors in both emerging markets and developed markets in this. For emerging markets the case is clear: China’s businesses are key to the growth of their own markets (whether in the real economy or money markets) and this drives capital inflows and outflows. Delta Economics has downgraded its forecast for Chinese trade in 2014 from 6.1% growth at the end of last year to 5.3% now suggesting a tough year for these markets.

For the developed world, the apparent bullishness is still not pricing in the risks in emerging markets. These risks are manifesting themselves through trade in the first instance but have the capacity to spill over into debt markets as well as disinflationary pressures and the potential for defaults become more evident. It might well be that these bulls could do themselves a lot of damage if they don’t look more closely at the Chinese shop.


(1) Anderlini, Jamil and Hornby, Lucy (January 10th 2014) | ‘China overtakes US as world’s largest goods trader‘ Financial Times

(2) Giles, Chris (April 30th 2014) | ‘China poised to pass US as world’s leading economic power this year‘ Financial Times

(3) Wolf, Martin (May 2nd 2014) | ‘China: On top of the world‘ Financial Times

Trade Returns?

Why Obama was wrong to leave Japan without a deal | There is little doubt that President Obama’s visit to Asia was all about trade. The TransPacific Partnership (TPP) negotiations aim to enhance trade, economic integration and growth across the Asia-Pacific region particularly through the establishment of a free trade area (FTA) between the participants. That President Obama left Japan without an agreement is significant for the future of the TPP and his warnings to South Korea about its treatment of US exporters did nothing to reassure markets that the agreement was any closer.

However, at first glance, the relationship between inter-regional trade and key Asian markets and currencies would suggest that there is little for markets to be concerned about. US exports to and US imports from key countries within the region are strongly and negatively correlated with the Hang Seng Index (all above -0.72) and with the S&P 500 (again, all above -0.55). Similarly, Indonesia’s trade with the US is mildly but negatively correlated with the Rupiah’s value against the US dollar and India’s trade is mildly but again negatively correlated with the value against the US dollar of the Rupee. The only exception is Thailand: its exports to the US are highly and positively correlated with the Bhat’s value against the US dollar at 0.85.

If the links are so weak with currencies and strong but negative with key markets, why attempt to build a Free Trade Area? The conclusion from these largely negative correlations must surely be that Asia-Pacific is better served by intra-regional trade. The US, in this context has more to gain from the relationship than does Asia.

Japan-US trade is a proxy for countries elsewhere in the region and illustrates how the relationship between equity and currency markets and US-Asia trade has broken down since the financial crisis. For example, the relationship between Japanese and US trade was positively correlated with the Nikkei until July 2009. Although exports from Japan to the US continued to grow until September 2011, the correlation turned negative after that point and is particularly marked since the beginning of 2013, ironically, the start of President Abe’s tenure, as illustrated in Figure 1. While overall the correlation is negative at -0.55, much of this is accounted for by the post-crisis period.


Figure 1 | Value of Japanese exports to the United States, June 2001-Dec 2014 (USDm) vs Nikkei Last Price Monthly, June 2001-March 2014

Figure 1 Source | DeltaMetrics 2014

Similarly, as with other economies in the region, there is also a weak, but negative correlation between Japan’s exports to the US and the value of the Yen against the USD (Figure 2).


Figure 2 | Value of Japan’s exports to the US, June 2001-Dec 2014, USDm vs Yen per US Dollar, Last Price Monthly, June 2001-March 2014

Figure 2 Source | DeltaMetrics 2014

Again, the most marked post-crisis turning point in the relationship between exports to the US and the value of the Yen is at the start of Abenomics where the Yen has been depreciating against the dollar. This cannot be seen as anything to do with trade HGH since it is a deliberate policy choice, and the correlation, -0.29, reflects that. However, what is very clear from Figure 2 is that the currency depreciation is not having a marked effect on increasing exports to the US.

And again like other countries in the Asia-Pacific region, Japan is heavily dependent on intra-regional trade: some seven out of ten of its top export destinations are within the region. The correlation between Japan’s terms of trade (the value of exports in relation to the value of imports) and the value of its currency against the dollar is positive at 0.79 suggesting that the depreciation of the Yen is likely to be important in shoring up the value of its exports more generally.


Figure 3 | Japan’s terms of trade (value of exports/value of imports), June 2001-Dec 2014 vs JPY per US Dollar, Last Price Monthly, June 2001-March 2014

Figure 3 Source | DeltaMetrics 2014

These negative correlations between trade and equity and currency markets are replicated across the region. Indian trade with China is negatively correlated with the value of the Rupee against the US Dollar, for example. But this should not be a surprise. Much of Asia is still emerging and all of Asia-Pacific is heavily dependent on trade with itself. The structure of trade is, even between advanced economies within the region and less advanced economies, dominated by commodities and intermediate manufacturing; the equity and currency values, in contrast, have been heavily driven by speculation in the post crisis period and while South-South trade remains set to grow by just 5.3% over the next year it will be some time before this type of hubris resumes (Figure 4).


Figure 4 | USDbn value of North-North and South-South trade, June 2001-Dec 2015

Figure 4 Source | DeltaMetrics 2014

Neither the US nor Asia can afford to leave the negotiations in limbo, not just because of the importance of export-led growth in a sustainable global recovery. There are two reasons for this. First, an FTA in the Asia-Pacific region that extends beyond the South-East Asian nations (already represented through ASEAN) would create advantages from the reduction of costs of trade between nations and potentially help to shore up the south-south trade that was so much a feature of post-crisis recovery but that has waned since.

But second, the US would become a minority trading bloc accounting for just under 12% of world trade compared to the nearly 35% of world trade that the Asia-Pacific region accounts for and the just over 34% that the European Union accounts for including intra-regional trade. In the end, by leaving Asia without a trade deal, the US has weakened rather than strengthened its position: China is currently excluded from TPP but is critical to its trade structure. There is, potentially, more scope for an agreement between all nations in the region including China than there is between the region and the US if the US does not take a pragmatic approach to negotiations. President Obama and his team should be thinking about trade returns in every sense.